How to Think About the Biggest Risks

Last week the Economist Intelligence Unit, the research division of the company that owns the magazine The Economist, released the latest version of its global risk assessment. The list made headlines because it included a certain former reality TV star and Republican presidential candidate among the “top 10 global risks” alongside things like terrorism and a Chinese economic collapse. But beyond the fact that attaching the words “Donald” and “Trump” to anything seems to make it newsworthy, what can investors learn from this list of global risks?

The main takeaway is the importance of political risk, a concept referring to political changes that can affect the value of your investments. While a few items (such as currency volatility and investment in the oil industry) are economic risks, most of the EIU’s list relates to politics and government policies. These include Russian military adventurism in Ukraine and the Middle East and the possibility that the United Kingdom will leave the European Union. As we’ve noted in the past, there’s evidence that political risk has been rising in recent years, and the EIU’s focus on such risks affirms that conclusion.

The prevalence of political risk suggests that investors should be wary of concentrating too much of their portfolio in any one part of the world. Even if the region’s economic potential offers the possibility of high investment returns, politics can interfere. But that doesn’t mean that fearful investors should avoid having international investments in their portfolio. After all, as the tumult of the current US presidential campaign shows, the next market-rattling political risk could be in United States.

Furthermore, trying to avoid risks altogether is generally a recipe for poor investment performance. Taking on risk is what creates the possibility of earning more than meager returns on your investments, and political risk is no exception. Rather than trying to completely avoid political risks, a better approach is to manage them. That means understanding the political risks your portfolio is exposed to, verifying that you’re comfortable with how much they can affect your wealth, and diversifying to ensure that any one risk can’t cause too much pain.